ERISA Stock Drop Litigation Against Financial Institutions Sheila Finnegan, Mayer Brown LLP Reginald Goeke , Mayer Brown LLP Mayer Brown is a global legal services organization comprising legal practices that are separate entities ("Mayer Brown Practices"). The Mayer Brown Practices are: Mayer Brown LLP, a limited liability partnership established in the United States; Mayer Brown International LLP, a limited liability partnership incorporated in England and Wales; and JSM, a Hong Kong partnership, and its associated entities in Asia. The Mayer Brown Practices are known as Mayer Brown JSM in Asia.
Nearly Two Dozen Sub-Prime Stock-Drop Cases Filed Over Past Year Defendants Include: • Lehman • Many actions related to • AIG Brothers companies caught in sub- prime market correction • Beezer Homes • Lincoln National • Targets are companies • Bear Stearns • MBIA with substantial stock- • Citibank • Merrill Lynch drops/bankruptcies • Countrywide • Morgan Stanley • ERISA cases represent perceived benefits to • Fifth Third • Regions Plaintiff counsel (including Financial Corp. • Freemont lower pleading threshold, General • UBS access to discovery, second bite at apple) • Hartford • Washington Mutual • Huntington BancShares • Wachovia • IndyMac • Wells Fargo 2
ERISA Stock Drop Cases: What they Are • Action on behalf of defined contribution plans What (e.g., 401(k), ESOP) They Are • Based on loss to plan as a result of plan investment in company stock • Breach of fiduciary duty of prudence for offering Typical employer stock as plan option Allegations • Breach of fiduciary duty by misleading participants into investing in company stock (Enron) • Breach of fiduciary duty for failing to inform participants of material information related to company • Other Alleged Breaches: Monitoring, Loyalty 3
Example Allegations in Subprime Stock-Drop Cases • Plan’s Investment in Citigroup was imprudent due to mismanagement and poor business practices, including: Citigroup • Failing to disclose liabilities from off-balance sheet SIVs • Causing SIVs to issue debt based on misleading statements • Extending “low documentation” loans without considering risk • Failing to adequately disclose Citigroup’s subprime exposure • Understating loan loss reserves • Plan’s Investment in Bear Stearns was imprudent because: Bear • Bear spent billions buying subprime loans despite increasing Stearns delinquency rates • Bear failed to adequately disclose subprime loan loss exposure • Bear understated its loan loss reserves • Bear operated without requisite internal controls 4
Typical Merits Defenses Raised In Stock-Drop Cases • Presumption of Prudence based on 404(a)(2) Prudence • Procedural Prudence Claims • Substantive Prudence • No Disclosure Obligation Disclosure • No Loss Caused by Alleged Disclosure violation Claims • Misstatements not Made in Fiduciary Capacity • Individualized Issues Raised by 404(c) Class Certification • Individualized Issues Raised by Disclosure Claims 5
Use of Presumption of Prudence Depends on Three Key Issues • Presumption based on ERISA 404(a)(2), and principal that administrators are expected to follow terms of Plan 1. Does Plan Support • Is the Plan an ESOP or EIAP Presumption • Do the Plan provisions related to the company stock use mandatory, suggestive or permissive language • Whether continued adherence to Plan’s terms was in keeping with Settlor’s expectations 2. Do Facts of case rebut • Mere stock fluctuations typically not sufficient. Presumption • Rebutting presumption often requires a precipitous stock decline and knowledge of impending collapse of company 3. Application of • Twombly v. Bell Atlantic Presumption at • Edgar v. Avaya Motion to Dismiss 6
Defending Merits of Prudence Claims Factors • Due diligence with respect to Procedural corporate transactions Prudence Cases • Regular consideration of • Nelson v. IPALCO , 480 F. whether to offer company stock Supp. 2d 1061 (After trial court found no • Seeking outside legal opinions imprudence even though • Appointing independent fiduciary stock declined 90%) • DeFelice v. US Airways, • Fiduciary need not predict future 497 F.3d 410 (After trial, Substantive of company’s stock price court found no Prudence imprudence even though • Analyst recommendations company filed bankruptcy) • Bond ratings • Shirk v. Fifth Third • Investments in company stock Bancorp (SJ finding by institutional investors presumption of prudence not overcome) • Relative stock-price performance compared to market or peers over class period 7
Theories for Defending Disclosure Claims • IPALCO (7th Cir): Plaintiffs allege that fiduciaries Disclosure should have disclosed own sales of stock. Obligation Limited • Court finds no duty to disclose non-material information; Inside sales were disclosed and did not move market, therefore immaterial • Reliant Energy (5 th Cir): Securities filings were Statement not required to be made in corporate capacity; They made in Fiduciary were not fiduciary statements even though Capacity incorporated in S-8 and 10a Prospectus • Avaya (3rd Cir): Plaintiff argues that adverse No Harm From Lack of Disclosure information should have been disclosed earlier • Court finds that under efficient market hypothesis, market would have adjusted to disclosure of adverse information before Plan or participants could have sold shares 8
Potential Damages Difficult to Predict • No court has yet found liability after a trial Risk of Liability • Presumption of prudence is increasingly being applied Improving • Likely that more cases will go to trial • Plaintiffs claim loss should be measured by “best alternative investment.” ( But see Leister v. Dovetail Size of Liability (7 th Cir. Posner) (rejecting that measure of damage)) Difficult to • Potential recovery by “holders” may depend on liability Predict theory • In re Delphi Corp. ERISA litigation ($47 million settlement) Settlements can • In re General Motors ERISA litigation ($37.5 million be Expensive settlement) • Lively v. Dynegy ($17.9 million settlement) 9
Resolution of Subprime-driven ERISA Stock-Drop Cases Will Vary by Facts of Case and Court • Plaintiff alleged that investment in Huntington Bancshares became Huntington imprudent when company merged with Sky Financial Group, which had a Bancshares $1.5 billion subprime exposure. S.D. Ohio, 2:08- • Court dismissed complaint, in part because: cv-0165 (Feb. 9, • public pension plans continued to invest in Company stock. 2009) • Hungtington’s stock price moved in tandem with its peers. • No “red flags” that Defendants failed to see. • Court noted unprecedented, ongoing credit crisis. • Court noted that the courts “are currently experiencing a significant rise in ‘stock drop cases’ due to the current status of the Stock Market and the economic climate in general.” • Plaintiff alleged that investment in company stock were imprudent NovaStar because the company business relied on subprime mortgages for Financial revenues, and because of improper conduct in originating those loans. W.D. Mo., 08-cv- • Court denied the motion to dismiss, finding the complaint adequate 00490 (Feb. 11, where it alleged that there was a precipitous decline in company stock 2009) price and that Defendants knew or should have known of the impending collapse of the company. 10
Strategies to Minimize Risk and Expense • Clearly demarcate responsibilities in Plan documents, Limit including appointment and oversight Executive • Remove senior executives and board members from Liability committees with administrative responsibilities • Consider using independent fiduciary • Revise plan to hard-wire company stock as option Revise within plan; or Plan • Remove company stock from plan options • Review investment options on regular basis Procedural • Implement regular monitoring process over Steps investments 11
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